3. Higher interest rates historically favor value investing at the expense of growth strategies. It is rational to want to pay-up for something that offers growth, in a world where growth is quite scarce. This is part of why “growth stocks” have done so well over the past decade. We have lived through a prolonged period of stagnant and anemic economic growth from 2009-2016. Higher interest rates could bring with it a broader set of attractive alternatives and will cause growth to look less unique. We have argued for some time that this market will eventually broaden out, and perhaps the market volatility we witnessed in February was a harbinger of that idea.
4. Dividends matter. Well, they used to anyway. Today, the top five weighted stocks in the S&P 500 are Apple, Microsoft, Amazon, Facebook and JPMorgan. We doubt anyone owns Apple for its 1.4 percent dividend yield, Microsoft for its 1.8 percent, and Amazon or Facebook which pay no dividends. Dividend income contributed an important 42 percent of the total return experienced by owning the S&P 500 from the 1930’s until 2012. For two of those decades, the 1940s and 1970s, dividend income contributed no less than 75 percent of the total returns
5. Earnings matter. John Bogle does a good job of tracking what he calls “Fundamental Return” vs. “Price Return” of the S&P 500, and here is what it looks like:2
We do not pretend to know when the popularity of the ideology surrounding passive investing will exhaust itself or whether it will ever end. What we do know is some of the ways it has impacted or exacerbated today’s market. We also know that market fundamentals ultimately revert to long- term averages, and to us the current circumstances seem out of whack. At market extremes, there is money to be made that we must chose to forego. As always, we will gravitate toward owning high quality businesses offered at attractive valuations. It is our belief that our value opportunity set is extremely attractive right now relative to what the S&P 500 Index and other disciplines might offer.
Tony Scherrer, CFA, is director of research and portfolio manager at Smead Capital Management.
1Source: Semper Augustus Investments Group LLC, Double, Double Toil and Trouble
2Source: Robert Shiller